Calculating The Fair Value Of ADENTRA Inc. (TSE:ADEN)
Key Insights
ADENTRA's estimated fair value is CA$35.23 based on 2 Stage Free Cash Flow to Equity
With CA$36.91 share price, ADENTRA appears to be trading close to its estimated fair value
The US$42.83 analyst price target for ADEN is 22% more than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of ADENTRA Inc. (TSE:ADEN) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for ADENTRA
Step By Step Through The Calculation
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$72.1m | US$59.1m | US$51.9m | US$47.8m | US$45.4m | US$44.1m | US$43.5m | US$43.4m | US$43.5m | US$43.9m |
Growth Rate Estimate Source | Analyst x5 | Analyst x5 | Est @ -12.15% | Est @ -7.91% | Est @ -4.94% | Est @ -2.86% | Est @ -1.40% | Est @ -0.39% | Est @ 0.33% | Est @ 0.83% |
Present Value ($, Millions) Discounted @ 9.2% | US$66.0 | US$49.5 | US$39.9 | US$33.6 | US$29.3 | US$26.0 | US$23.5 | US$21.4 | US$19.7 | US$18.2 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$327m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$44m× (1 + 2.0%) ÷ (9.2%– 2.0%) = US$620m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$620m÷ ( 1 + 9.2%)10= US$257m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$584m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$36.9, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at ADENTRA as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 9.2%, which is based on a levered beta of 1.569. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Looking Ahead:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For ADENTRA, there are three pertinent items you should explore:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with ADENTRA (at least 1 which can't be ignored) , and understanding them should be part of your investment process.
Future Earnings: How does ADEN's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every Canadian stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
